The stranded assets problem

If you wanted to point to a single year as the source of the current challenges facing the California electricity market and the major choices it’s leaders are confronting, it would be 2002. This was the year of AB 117, the bill authorized community choice aggregation; the year of SB 1078 that established the original Renewable Portfolio Standard; the first year the major generation capacity contracted in response to the 2000-01 electricity crisis came online; and the year the CPUC started allowing utilities to negotiate long-term PPA contracts with independent power producers (IPPs / generators). No single one of these policies is the cause of the current turmoil but their convergence has given rise to a core problem in the changing California market: stranded assets.

The stranded asset problem is not new – it shows up in any basic investment risk assessment of any business. Even in the California utility market, the stranded asset problem arose in the early 90s when the legislature and the Public Utility Commission (CPUC) were mapping out how to deregulate the electricity market – forcing the IOUs to sell all but a few of their physical generating assets. But unlike Finance 101 or mid-90s California, this time stranded assets are not physical (or technical) investments – they are contracts. Specifically, long-term Production Procurement Agreements (PPAs) with IPPs.

These contracts establish a set $/kwh price (plus additional prices for frequency and other ancillary services) and a minimum purchase amount by the utility annually for the life of the contract (usually 25-30 years). These prices are then passed directly through to the customers on the “energy” line item of their bill. In response to the RPS, several of these new contracts over the next 10 years were for renewable power – solar and wind – at prices that reflected the cost of these technologies before the significant drop in $/W in the early 2010s. Hence the bid price of a solar plant into the CAISO wholesale market is exponentially lower now than the contracted price the utility (and thus customers) end up paying. These contracts also assumed a load growth over that 25 year period that has, in reality, flatlined after the 2008 economic crash and doesn’t look like it’s coming back any time soon, if at all.

Many point to the rise of CCAs in California, starting in 2010, as reflective of the public belief that utilities are not moving fast enough to run the entire electric grid on 100% renewable energy. However, while that is a strong local selling point, the state could reach that goal with the simple act of passing SB 100 and moving (and redefining) the RPS to 100% renewable. What makes the CCA case so strong is the economics – the opportunity to deliver cheaper power to communities because renewable power in California is significantly cheaper than what we’re paying for it.

But there is a larger structural challenge that this decision – depending on its result – will either inform or avoid. The issue of stranded assets and the incentive structure of the cost-of-service utility revenue model. Both Moody’s and the Rocky Mountain Institute have released reports in the last week pointing to the risks to major utilities in further investment in natural gas generation. Not coal. Natural Gas. What they both highlight is that with the increasing growth and decreasing price of renewable generation – utility-scale, corporate direct access contracts, and distributed energy resources – significant investment is more natural gas generation, utilities and energy companies are risking a serious stranded asset problem not just in California but across the country.

In 2002, California was already exerting significant political effort to transition the electric grid onto cleaner natural gas as a “bridging fuel” to renewable energy. The general market and investment expectation was that that bridge would be necessary for about 30-40 years until renewables could really take over the majority of power production in the country. It turns out renewables are running 15 years ahead of schedule and both the political and financial worlds have been caught off guard. The stranded asset problem is rolling down the tracks and picking up speed. It is imperative we come to a solution – one that will likely leave everyone a little pissed off but hopefully no one completely screwed over – before we get run over by the oncoming train.